MoneyUnder30.com
MoneyUnder30.com

Q&A: I’ve Maxed Out My 401(k); Where Should I Invest Next?


Occasionally I publish answers to select readers’ money questions. I welcome your opinion in the comments. Send questions to david@moneyunder30.com. I can’t get to them all but will do my best!

Q: I’ve been employed for six months. I’m 30 (school took a long time) so this is my first time investing. I am maxing out my 401(k) at work but want to save more because I started late. I was looking at a Roth IRA but I earn too much ($105,000 plus a bonus). What kind of saving options do I have and what is the best way to save the annual bonus I expect to receive? —Carly

A: As long as you have a 401(k) at work, maxing it out is your best bet at your current income level because, as you discovered, you’ll be excluded from making a full Roth IRA contribution. 

Do you have a cash emergency fund? Although a savings account isn’t an investment per se (interest rates won’t even cover inflation), I recommend everybody have at least $5,000 (or the equivalent of six months’ expenses) in cash that’s quickly accessible. Don’t have this yet? Simply stash your bonus away in an online savings account for a rainy day.

Got the emergency fund covered? Then to continue investing, it’s time to look at a taxable investment account.

The good news is you can invest however you want and you can access your money whenever penalty-free. (With a 401(k) or IRA you typically need to wait until retirement to withdraw the money or face paying a 10% early-withdrawal penalty to Uncle Sam.)

The downside is that when you sell these investments you’ll pay capital gains taxes on any returns (although you can deduct losses sometimes, too). To minimize your tax bill, hold onto investments for at least one year.

A simple mutual fund account at a place like Vanguard or Fidelity is a fine start. Look for mutual funds with low expenses.

Betterment is another option: it’s a pretty cool new investing platform that makes investing in the stock market about as simple as opening a savings account.

If you continue to max out your 401(k) and invest more on top, you should build a nice portfolio quickly.

If you ever decide you want help choosing the right investments in your taxable account, you may consider hiring a financial advisor, especially once you have $150-$200k invested. My advice: Look for a fee-only financial planner who will serve as a fiduciary (meaning he or she must put your financial interests first). You can find a list at the National Association of Personal Finance Advisors.

###

Get access to our best money hacks:

Join over 11,000 other young professionals and learn how to get out of debt by 30, increase your income this year and invest for financial freedom.




100% free! I will NOT spam you and I will NOT share your email.

About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. Pretty good advice. I think a good point is that once you have a significant amount invested ($200k) you should definitely consider a fee only financial planner.

  2. Some great advice for someone in this set of circumstances. A fee based financial planner is always the best way to go over a free (commission) planner. You really end up getting what you pay for… A free service the incentive is to give you the product that makes them the biggest commission but when you pay for the advice they have a fiduciary duty to look out for your interests. Always make sure your planner is a CFP as well. CFP need to pass a rigorous test, take and oath to out the client’s interest first and maintain ongoing education.

  3. Any thoughts on having him contribute to a traditional IRA and then converting to a ROTH. This is a completely ok way around the income limitation. He may not get a tax dedution but may be able to do this annual.

    Any thoughts on contributing to a traditional IRA before a taxable account?

    • David Weliver says:

      Hi JR,

      Yep, doing a Roth IRA conversion is certainly an option.

      I didn’t get into it here for simplicity’s sake, but anybody can contribute to a nondeductible IRA regardless of income and then convert it to a Roth the following year. When you covert, you pay your regular income tax rate on the amount converted. If you don’t mind the hassle or setting aside money to pay the taxes at the time of conversion, this can be a smart move.

      In this reader’s case, because she’s covered by a 401(k) plan at work, her income precludes her from contributing to a traditional (deductible) IRA. Whether or not she wants to convert to a Roth, she can always contribute to a nondeductible IRA, which still has the benefit of deferring taxes on any gains until retirement. This Motley Fool article explains why it’s probably not worth it, however, unless you plan to do the conversion.

      • “I didn’t get into it here for simplicity’s sake, but anybody can contribute to a nondeductible IRA regardless of income and then convert it to a Roth the following year. When you covert, you pay your regular income tax rate on the amount converted.”

        2 points for clarification:
        1) you do not have to wait until the next year to convert to a Roth. You can do it immediately.
        2) If you convert a nondeductible IRA, you will only pay tax on the gain in the account between the time you contributed and the time you converted. Your basis is the non-deductible contribution. If you convert immediately, there will be no gain and no tax.

        • Just another point to clarify. A nondeductible IRA is not a separate type of account from a Traditional IRA. You can make non deductible IRA contributions to a Traditional IRA that you already have set up.

  4. Great advice! If I was maxed out in all other areas… I’d consider putting a lump sum on the mortgage as well.

  5. I make $155k plus bonus. I obviously do not qualify to contribute to a Roth IRA nor can I make deductible contributions to a traditional IRA. Every December, I put $5k in my traditional IRA. (You don’t have to wait until December. You could also schdule an automatic transfer of $416 every month from your bank account to your traditional IRA.) This is a nondeductible contribution obviously and I already paid taxes on the money. The very next day (Fidelity makes you wait one day), I convert my traditional IRA to my Roth IRA. I do not pay any taxes on the conversion. It literally takes about 10-15 minutes to do this online with my Fidelity accounts. I keep my Roth IRA funds in an aggressive asset allocation fund since I’m 28. I schedule automatic investments of the 5k throughout the following year (an investment once every two weeks) in my asset allocation fund so that I can take advantage of dollar cost averaging. By the following December, the full 5k has been invested and I contribute another 5k. This money will grow tax free and can be withdrawn tax free once you retire. This is definitely what you should do once you max out your 401k. Once you do this, open a regular taxable brokerage account and invest in ETFs and
    low cost mutual funds. Your expense ratios shouldn’t go over 1%. And there’s really no substitute for a nice emergency fund sitting aside in an online savings account so get that going as well. The peace of mind is worth it. If you would like to set aside more but get a better ROI, try a bond ladder. Fidelity makes that really easy.

  6. What a great list of suggestions! Thanks for sharing. Congrats to everyone who has already maxed out their 401(k) and Roth IRA – what an accomplishment.

  7. My concern about Roth IRA’s is that I know what my tax rate is now, but I don’t know what it will be in 30 years. It may sound foreign, but there may not be an income tax by the time I retire. For me, it makes more sense to take the tax advantages now, because I know what they are and can count on the benefit.

    • The argument about Roth 401 & IRAs is that while the tax rate 30-40 years down the road is unknown, we’re likely at our lowest earning rate (and tax rate) now. That’s why younger people should aim for the Roth.

      Plus, the government is not going to pass up on the tax revenue. I doubt in 30-40 years if the tax rate is 0% the government would say “well, we never taxed you on your wages when you were in your 20s but since the tax rate is 0% now, you don’t owe any taxes on it now either”

    • The beauty and benefit of Roth IRA is that ALL GAINS in Roth are tax-free if you take distribution at retirement age. Since the contribution is already post-tax – there is no tax on any monies in Roth IRA.

  8. If you have the option of a Roth 401(k) you should max that out instead of the traditional one because, since your contributions are after-tax, it effectively has a higher limit.

  9. Anyone who plans on maxing out their 401(k) (like I am) should be sure to make sure they’re not maxing their contribution too early into the year. Anyone whose employer is matching contributions will stop once you hit the 17k limit. Thus, if you hit your $17k limit in August your employer will stop contributing since you’re not contributing…don’t miss out on the free money your employer is offering.

    • I believe Colin should check with his HR/payroll department, as this advice is not correct for most folks. If your company matches 6% of your 401(k) contributions, the sooner your get the money in your account the better. 6% of 17k is the same, regardless if you max it out in the first month, or by the end of the year. Some employers only match a max % each month, but that is very rare. Please ask your company’s financial folks before you hold off on contributions as suggest by Colin, as his advice is (luckily) not applicable to most people.

      • Ben, I think you’re incorrect. Most companies match a percentage of what you contribute. If you contribute 6% and they have a 6% match, they’ll match the full 6%. If you contribute 5% & they’ll match up to 6%, they’ll only match 5%.

        And to clarify what I’m saying, if you reach your $17k max earlier in the year (say October), you obviously can’t contribute anymore yourself. However, because most companies will only match if you’re contributing, since you’re not contributing from October thru December, they won’t contribute either.

        Hence, it does you no good to max out early in the year because once your contributions rate drop to 0%, your company does as well.

  10. What if you’re near the Roth limit and approaching 30? Does it make sense to start a Roth if you will only end up contributing 10k to it?

    • Roth limit on an IRA or 401k or are you referring to the income limit for IRA contributions?

      My mantra is if you’re young, no matter how much you can save, save it now, post tax, and enjoy as that money compounds for another 30-35 years and is tax free at withdrawal.

    • You could, for whatever reason, have a year where you earn less, e.g. when you take maternity/paternity leave or between jobs, which would allow you to contribute to the Roth. Also, if you rollover a Roth 401(k), I believe it rolls into a Roth IRA, not into a Rollover IRA, so that is another way to “add” funds to your Roth IRA down the line. I don’t know if I will ever be able to contribute directly to a Roth IRA again, but the Roth 401(k) funds will definitely be rolled into it at some point when I change jobs.

  11. uh, Carly, are you positive you don’t qualify? I hate to point the obvious, but if your 105 is your GROSS income, surely your MAGI is less than the 105 limit? You just started working, so I figure this is worth a mention. If you make a wall st bonus then nevermind.